Under the headline ‘Between Wishful Thinking and Feasibility: How to remove Obstacles to True Competition and a Common Beneficial Single Market in the EU’ a policy maker, industry experts, an economist and a think tank expert discussed practical hurdles and impediments to further financial integration and what needs to be done to achieve a fully integrated single market in the EU.
Financial Stability Conference 2019
28 October 2019
Panel II – Discussion
Between Wishful Thinking and Feasibility: How to remove Obstacles to True Competition and a Common Beneficial Single Market in the EU
with Costanza Bufalini, Head of Regulatory Relations and Group Regulatory Affairs, UniCredit; Willem Pieter De Groen, Head of Financial Markets and Institutions Unit, CEPS; Dr. Peter Grasmann, Head, EU/Euro Area Financial System Unit, European Commission; Michala Marcussen, Group Chief Economist and Head of Economic and Sector Research, Societe Generale; Dr. Srobona Mitra, Senior Economist, European Department, International Monetary Fund; moderated by Prof. Joachim Gassen, Chair of Financial Accounting and Auditing, Humboldt University Berlin
Panel II – Discussion
Joachim Gassen stated the panel‘s topic of transparency and how to overcome obstacles to true competition in the EU Single Market and initiated the first round of introductory remarks by the panelists.
Srobona Mitra started with some brief insights into the Capital Markets Union (CMU) from a recently published IMF paper. The European capital market in terms of listed stocks and bonds only covers 28 percent of funding sources. It is further segmented along national lines, as equity portfolios of insurers and pension funds mainly originate from their national corporates. This kind of fragmentation is costly and translates into higher debt funding costs of up to 30 to 60 basis points for Spanish, Italian or Portuguese firms in contrast to a similar firm in Germany. Moreover, there is less private risk sharing, and consumption in Europe is four times more sensitive to asymmetric shocks compared to the US. Deficiencies in regulatory and auditing quality in addition to insolvency frameworks constitute the main concerns for financial market participants.
Deficiencies in regulatory and auditing quality in addition to issues of insolvency frameworks constitute the main concerns for financial market participants.
In contrast, removing these obstacles would be highly beneficial, for instance, upgraded insolvency frameworks in Italy could reduce its corporate funding costs by 25 basis points. Improving regulations and harmonizing insolvency regimes could double cross-border intra-EU portfolio flows and increase the interconnectedness of banks‘ balance sheets resulting in deeper integrated capital markets and improved risk sharing. Therefore, in terms of the European stock market, it is advisable to provide and increase transparency through a centralized, standardized and on-going reporting framework by all issuers.
On the regulatory front, it is further suggested to have a more independent board of the European Securities and Markets Authority for greater pan-European supervisory convergence as well as a more centralized oversight of systemic intermediaries like central counterparties (CCPs) and investment firms. The tax and cost treatments of the proposed pan-European pension product should be revisited and lowered, while the case of Brexit shows that the EU needs close regulatory cooperation with all third countries. Finally, insolvency processes should have a ‚name and shame‘ approach as well as centralized minimum standards and provide more comparable data of insolvency regimes for bench-marking purposes.
Resonating with the first panel, Peter Grasmann considered European banking to be much more stable than in 2008 but also less profitable and over-banked. Neither the provision of cross-border services nor mergers and acquisitions result in deeper market integration. Since 2008 banks retreated to national borders for stability reasons having left the common market less integrated and vibrant as we might wish, he said. The relationship between stability, integration and competition is ambivalent, especially as the financial sector is far from textbook assumptions on perfect competition due to scale economies in the financial infrastructure, which CCPs, credit rating agencies, central securities depositories and investment banks benefit from. While the global integration of these European sectors is profound, the provision of services to European finance and economy is increasingly provided by third countries, which hence can be explained by imperfect competition and scale effects.Moreover, Brexit has forced Europe to concentrate more on those Member States, where banking intermediation prevails and capital markets are shallow or in some segments close to non-existent, instead of promoting integration by using the UK‘s financial hub. In relative terms, it has become less about integrating capital markets, but rather developing them in the first place, he said.
Since 2008 banks retreated to national borders for stability reasons having left the common market less integrated and vibrant as we might wish.
In line with Peter Grasmann, Willem Pieter De Groen agreed that after the last financial crisis the focus has been on stability. He argued that the previous fragmentation between 19 different countries was replaced with a single supervisory system that in practice separates larger significant from smaller less significant banks thereby resembling a two-tier system. This system also distinguishes between resolutions worthwhile in the public interest versus those that should fail under the insolvency regime.
Digitalization changes the dynamics in banking with new entries like Monzo, N26 and Revolut offering a broad range of banking services across borders and even the EU. They do not replace established banks yet, but they also show that banking services no longer require a physical network with branches. As these smaller and new or existing entrants overcome differences in the level-playing field, disrupt and succeed in the markets, they are more likely than M&As to induce structural changes in the banking sector. These new entrants can operate in the Single Market even though it is not yet a true common market in terms of harmonized rules and implementations across Member States, he said.
Fintech entrants overcome differences in the level-playing field, disrupt and succeed in markets, and thus are more likely to induce structural changes.
Subsequently, Costanza Bufalini stressed the importance of a Single Rulebook, harmonized rules and reducing National Options and Discretions (NODs) as well as ring-fencing for greater integration and stability in the Single Market, albeit there being little progress or even regress on these topics. As a consequence of fragmentation, banking groups cannot fulfill their role of local shock absorbers, since they are limited in allocating capital and liquidity, which has adverse stability effects on the banking sector as a whole. Especially in the context with low profitability, a truly European banking sector regulated by one set of rules is urgently required to attract investor‘s money from abroad. In contrast, regulation has not yet eliminated NODs that are most detrimental to banks‘ capacity to manage liquidity. Therefore, policymakers need to tackle this problem and revise the latest Banking Package that requires subsidiaries of fairly integrated banking groups, which are resolved under the single point of entry resolution strategy, to hold more loss-absorbing capacity than subsidiaries of third-country banks or US banks.
Single Rulebook, harmonized rules and less National Options and Discretions as well as ring-fencing are important for greater market integration and stability.
With insights for the European context, Michala Marcussen elaborated that public support played a major role in US history to develop deep and liquid capital markets. This support referred to the removal of obstacles to cross-state banking such as regulatory issues or limited types of financial activities that were allowed. Moreover, the development of the mortgage market as an integral part of the US capital market relied heavily on government-sponsored enterprises like Fannie Mae and Freddie Mac. Administrations for public support to help securitize SME loans, a pension benefits guarantee scheme and common deposit insurance through the FDIC were set up. Most importantly, the US has a single risk-free yield curve, whereas in the Europe system the risk-free rate is located along national lines, such that flights to national borders in terms of liquidity and risk-free rates will occur during crises.
To deepen the CMU, Michala Marcussen proposed that a sequential approach to a fiscal union and propositions on Eurobonds will need to be discussed. Without advanced public risk sharing it is hard to fully cut the sovereign-bank doom loop only through private risk sharing. Besides the main motivations of smoothing shocks, efficient monetary policy transmission and enhancing economic growth, a strong European financial sector is very much a strategic aspect today, especially in the light of global trade conflicts.
Without advanced public risk sharing it is hard to fully cut the sovereign-bank doom loop only through private risk sharing.
Summarizing the panel, Joachim Gassen questioned whether stability is the current most pressing issue in Europe or whether an alternative narrative is needed to push forward regulatory changes towards financial integration. Coming back to the issue of Italy‘s insolvency regime worthy of improvement, he insisted on further explanatory factors in terms of national inefficiencies.
Srobona Mitra noted that the IMF paper confines to the cost-benefit analysis that allows describing opportunities for improvement instead of political guidance, especially in the case of highly political insolvency regimes. One way to by-pass the political process and gain insights would be to conduct centralized benchmarking with newly collected data, while the ‚name and shame‘ approach can increase transparency on the effects of the regulatory environment in a given country. Peter Grasmann pointed out result-oriented benchmarking studies, however, are difficult due to the lack of data, for instance on how much time banks need to get collateral backing. Moreover, gradual improvements as threshold effects are often not good enough, such as when a bank reduces the time to realize its collateral from nine to six years, which presents an effective deterrent to cross-border banking.
In response to Joachim Gassen questioning why there is low motivation for regulatory reforms at the national level, Willem Pieter De Groen noted that the last financial crisis conveyed an acute pressure for regulators to make changes upon creating the Banking Union (BU), which at the moment is not the case. Moreover, the current system creates uncertainty on whether a SME bank faces resolution under the single point of entry strategy or the national regime, which leaves national supervisors uncertain about their interests being sufficiently protected in a crisis scenario. Referring to Costanza Bufalini‘s previous point, the resulting lack of trust may be at the core of why supervisors uphold NODs and oblige subsidiaries ex-ante to hold sufficient capital. In contrast, Costanza Bufalini suggested that this distrust, which roadblocks the Single Rulebook and completion of the BU, might result from an insufficient acknowledgment of the substantial progress already made on risk reduction.
Distrust might result from an insufficient acknowledgment of the substantial progress already made on risk reduction.
Referencing the ECB‘s financial stability report, ratios of Common Equity Tier 1 as well as short-term and long-term liquidity have increased, while non performing loans‘ ratios decreased. Regulation was warranted in the past, but is now likely to be excessive, which is to the disadvantage of the economy. EU institutions should rather evaluate the full effects of the already enacted regulations and conduct a comprehensive impact assessment. Finally, to move forward and increase trust between the Member States it might need a clear roadmap of what is still needed, but without raising the measuring stick along the way and requiring ever new risk reduction measures, she stressed.
Michala Marcussen added that in Europe, historical crises typically convinced people of the value of cooperation, for example, the creation of the single currency following turbulences in currency markets or the financial and debt crisis of 2011/12 for creating the Banking Union. But seeking unity just because of difficulties is not the most reliable approach towards integration and trust. There is no reason to be complacent, as the UK is about to leave the EU, partly also because its citizens might have lost trust in the EU. So far, markets had trust in Mario Draghi, who in his last ECB meeting highlighted the need for a fiscal union and warned against overburdening the ECB. The biggest danger we face today is that European citizens will lose trust in the central bank. Now it is up to the governments to extend more trust and take us forward, she emphasized.
The first question from the audience was about what kind of banking product might enhance more integration similar to what the EU roaming option is to the telecommunication sector. Willem Pieter De Groen replied that cross-border current accounts of payment present such a product, but considered European banking to be already better integrated than telecommunication markets, as respective networks and providers heavily stick to national rules.
On the relationship between rules and principles in banking supervision, Srobona Mitra responded that while regulations specify rules, financial sector assessments analyze the principle of supervision in terms of what day-to-day principles are used for instance when looking at balance sheets on-site or monitoring off-site. These principles of supervision vary a lot within the EU but could be more centralized at the SSM.
On the question of whether Member States are now resilient against subsequent recessions given their level and growth of NPLs, Peter Grasmann replied that with low NPL ratios around three percent across the EU banks are much better equipped than in 2008. However, critical NPL levels of above 44 percent in some Member States also indicate that policies and moral hazard issues can drive NPLs more powerfully than the business cycle.
A final remark questioned whether to address the trust issue between Member States, uncertainty implicit in EU legislation should be tackled first. Willem Pieter De Groen said that a recent study on deposit insurance schemes found that many NODs exist, such as Italian NPLs that used to be treated without ever touching upon the insolvency regimes thereby greatly reducing losses. Whether these kinds of measures can be used under the deposit insurance, however, remains uncertain, as the Banca Tercas case showed. Hence, it is partially the task of the Commission and authorities like the ECB to increase transparency and communicate more proactively, what they potentially are going to do, even though this might potentially reduce their room for manoeuvre in a crisis.
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